Investors are confronted with a pivotal choice: stick with the staunch S&P 500 or venture into the promising territories of emerging markets (EM).
This decision has sparked passionate debates among investors worldwide. While some swear by the reliability of the S&P 500, others are enticed by the potential growth awaiting in EM.
Investors are starting to challenge the status quo and suggesting a shift towards EM via Dollar-Cost Averaging into the MSCI Emerging Markets Index. Yet, as opinions collided and perspectives diverged, it became apparent that the decision isn’t as straightforward as it seems.
Disclaimer: This is not financial advice and you are responsible for your own investment decisions. When investing capital is at risk. This article may contain affiliate links.
S&P 500 vs Emerging Markets
The age-old question of whether to allocate investments to the tried-and-tested S&P 500 or the enticing frontier of emerging markets (EM) has resurfaced. With wealth advisors now presenting the case for an EM bull market.
Some advocate for a middle ground, while others stress the importance of embracing the uncertainty. Over the past 25 years, EM equities have often outpaced their DM counterparts. This is despite EM facing periods of lackluster returns.
Emerging markets have showed resilience in 2023 and delivered impressive returns. This is despite the challenges posed by the post-COVID-19 economic environment. Factors such as disciplined monetary policy, solid economic growth, and the tech boom have contributed to Emerging Markets success.
Meanwhile, many investment strategists suggest the S&P 500 is overvalued. With some even arguing the U.S. at the peak of stock market bubble, which is ready to burst?
Emerging Markets Show Promising Signs
Thornburg present a compelling argument for EM. They suggest the long-term case for EM remains robust, driven by factors like a growing middle class and declining interest rates.
M&G highlights three reasons for potential optimism in emerging market (EM) equities: undervaluation compared to global counterparts, a shift in corporate behavior towards greater capital discipline and shareholder returns. With improving fundamentals at the micro level.
Goldman Sachs Research forecasts a significant rise in the stock market capitalization of emerging markets (EMs). They project it to surpass that of the U.S. by the end of the decade.
Four Trends Behind Emerging Markets Growth
The past decade saw EMs grappling with currency woes and subdued corporate earnings. However, their prospects appear to be shifting. Alliance Bernstein outline four key trends are set to reshape the narrative.
Innovation as a Growth Driver: Technology and innovation are becoming primary engines for growth in EMs. This is empowering countries to leapfrog into competitive positions and enabling global participation in the innovation boom.
Reshoring Away from China: Companies are reconfiguring supply chains. The is a shift away from heavy reliance on China and bringing manufacturing closer to home in other EM countries like Vietnam, Bangladesh, and Mexico.
Changes in EM Benchmark Composition: The composition of EM benchmarks is evolving as innovation sweeps through industries. This is leading to a shift towards “new economy” stocks in sectors like technology and e-commerce.
Historical EM Performance Cycles: Historical data shows that EM stocks have delivered periods of superior returns compared to developed markets. This indicates the potential for a recovery after a period of underperformance.
The Shift In Market Sentiment Towards Emerging Markets
The shift is underpinned by expectations of income convergence between EMs and developed markets, with EMs’ share of global market cap expected to increase from around 27% currently to 55% by 2075. This is all according to Goldman Sachs forecasts.
This trend is driven by factors like equitization of corporate assets and deepening capital markets. Which suggests a potentially brighter future for EM equities. On the other hand, risks like rising protectionism and climate change could pose challenges to this outlook.
At the same time, we have started to see outflows from U.S. stocks. According to Reuters U.S. large caps saw $15.8 billion of outflows in the week, while stocks in general saw outflows of $19.6 billion. Which according to Bloomberg is the largest since 2022.
This is amid a backdrop where the S&P 500 had it’s worst week this year, at a time where some investors believe this is just the start of the bear market for the S&P 500 and the U.S. market.
S&P 500 Growth Estimates Vs Emerging Markets
Schwab estimate that U.S. large-company stocks are expected to return 6.2% annually over the next 10 years. This trails the expected 7.6% return for international large-company stocks.
Vanguard projects lower returns of 3.7% to 5.7% for U.S equities. Whereas Emerging Markets equities could return 6.1% to 8.8% annualised returns over 10yrs.
As a result, it’s hard to find a technical analysis that suggests U.S. equities will outperform other markets. Sky-high valuations appear to be driven by speculation around the Artificial Intelligence markets. The question is, will earnings reports back this up?
Conclusion Emerging Markets vs S&P500
China’s erratic recovery and the reshoring trend pose risks. However, the potential catalysts for EM outperformance provide a compelling case for investors to reconsider their EM allocation.
The shift away from a dependence of China may reduce it’s growth prospects, may have drive growth and investment in alternative Emerging regions.
Whether you’re a seasoned investor or just dipping your toes into the market, exploring opportunities in emerging markets could be your ticket to financial growth and diversification.
6 Emerging Markets Funds That Make My Personal Shortlist
As I pivot towards diversifying my investment portfolio, I’m increasingly drawn to the promising opportunities offered by emerging markets. Recognizing the potential for growth and resilience in these dynamic economies, I’ve decided to increase the weighting of emerging markets into my investment strategy.
After thorough research, I’ve identified a selection of funds, each with its unique approach and track record. After careful consideration, I’ve decided to add one of these funds to my portfolio, confident that it will contribute to the long-term growth and stability of my investments.
There is one fund in this shortlist that returned over 70% in just one year, outperforming it’s Emerging Markets benchmark by almost 30%! The shortlist also contains two low-cost index funds which will likely make the cut.
